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The Federal Reserve: Prophets and losses

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By Thomas Sowell

Published: Thursday, Feb. 7, 2013, 8:55 p.m.

Now that the federal government is playing an ever larger role in the economy, a look at Washington's track record seems to be long overdue.

The recent release of the Federal Reserve Board's transcripts of its deliberations in 2007 shows that its economic prophecies were way off. Even after the housing market began its collapse in 2006, Federal Reserve Chairman Ben Bernanke said in 2007, “The impact on the broader economy and financial markets of the problems in the subprime market seems likely to be contained.”

It turned out that financial disasters in the housing market were not “contained,” but spread out to affect the whole American economy and economies overseas. Then Bernanke said: “It is an interesting question why what looks like $100 billion or so of credit losses in the subprime market has been reflected in multiple trillions of dollars of losses in paper wealth.”

What is an even more interesting question is why we should put such faith and such power in the hands of a man and an institution that have been so wrong before.

We all make mistakes. But we don't all have the enormous power of the Federal Reserve System — or the seemingly boundless confidence that Bernanke still shows as he intervenes in the economy on a massive scale.

Not only does the Federal Reserve System control the money supply and regulate banks, the Fed's willingness to keep buying hundreds of billions of dollars' worth of government bonds makes it easier for the Obama administration to keep engaging in massive deficit spending that runs up a record-breaking national debt.

The reason that the Federal Reserve can afford to continue buying huge amounts of government bonds is that the Fed is authorized to create its own money out of thin air. The Fed uses the fancy term “quantitative easing,” instead of saying in plain English that it is essentially just printing more money.

Being wrong is nothing new for the Federal Reserve System. Since this year is the one hundredth anniversary of the Fed's founding, it may be worth looking at its history.

The Federal Reserve was supposed to prevent shocks to the economy that can come from drastic inflation or deflation, and reduce the dangers that can come from widespread bank failures. These are all good goals. But what is the Fed's track record?

In the hundred years before there was a Federal Reserve System, inflation was less than half of what it became in the hundred years after the Fed was founded. The biggest deflation in the history of the country came after the Fed was founded, and that deflation contributed to the Great Depression of the 1930s. As for bank failures, they reached levels unheard of before there was a Federal Reserve System.

“Progressives,” then and now, seemed to think that, if those who made government decisions had no financial interest in those decisions, then they could be trusted to wield their powers in the public interest.

But the enormous power wielded by the unelected leaders of the Fed over the economy, unchecked by the constraints of the market, has repeatedly turned out to be more than human beings can handle.

Coming Saturday: Prophets and losses part 2.

Thomas Sowell is a senior fellow at the Hoover Institution, Stanford University.

 

 
 


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